How Do I Decide Which Business Entity Is Right For Me?

You are ready to embrace the entrepreneurial life. This is an exciting time—but also one of uncertainty. Before you proceed with an LLC operating agreement or articles of incorporation, you will need to make arguably the most important decision of all: business entity classification. From sole proprietorship to C corp, options abound. Tread carefully; your choice could impact taxation, liability, and recordkeeping for years to come.

Business Entity Options

Before you proceed, it is important to gain a basic understanding of your options. The following are the most common business entities:

Sole proprietorship – A sole proprietorship is an unincorporated entity headed by a single entrepreneur. Aspiring business owners need not take formal steps to form this type of business. In fact, if you currently do business on your own (such as freelance writing), you may already run a sole proprietorship. As a sole proprietor, you will report income and losses via Schedule C and Form 1040. A sole proprietorship does not necessarily remove the need for licensure on a local, state, or federal basis. You can either choose a separate name for your business or use your own name.

Partnership – Partnerships largely resemble sole proprietorships, except that they involve more than one entrepreneur. The term 'partnership' typically refers to a general partnership, in which all partners share liability. Another option is a limited partnership, in which involved entrepreneurs operate as either limited or general partners.

C corp – When you picture a corporation, you probably imagine a C corp. After all, most large companies are classified as C corps, as are many small businesses. With this approach, the business is taxed separately from its shareholders or owners. C corps are subject to federal corporate taxation.

S corp – S corps and C corps hold much in common. The main distinction is that in an S corp all income, credits, deductions, and losses pass through to shareholders, who then report these figures on their own tax returns. For this reason, S corps are often referred to as pass-through entities. Qualifying companies cannot exceed 100 shareholders or one stock class. Additionally, S corps must be entirely domestic.

LLC – An increasingly popular option among solopreneurs, limited liability companies (LLCs) provide a valuable middle ground between corporate and independent approaches. LLCs retain many of the freedoms of sole proprietorships and general partnerships. Their main benefit is reduced liability. An LLC is not a corporation; as a hybrid entity it is 'organized' rather than 'incorporated.'

Key Questions to Ask As You Choose the Right Business Entity

You now understand the basics of various business entities. Like many entrepreneurs, however, you may struggle to weigh the benefits and drawbacks of a myriad of available approaches. Ask yourself these key questions as you determine which business entity can best meet your company's unique needs:

Do you work freelance? Do you primarily work on your own?

The freelance lifestyle delivers freedoms enjoyed by neither traditional employees nor corporate entrepreneurs. Freelancing also delivers unique challenges. For some, however, the risk of liability is a worthy tradeoff for full freedom.

Your best bet for retaining complete control while minimizing recordkeeping obligations is a sole proprietorship. While you will not benefit from the separation of personal and professional assets associated with LLCs and corporations, you will avoid the hassle of extensive bookkeeping. You will also get the final say when making critical business decisions. With a conventional corporation, you would cede extensive control to the board of directors. As a business partner, you would need to consult the other owner, depending on your partnership agreement.

If you are already in business, look carefully at your operation—you may already be a sole proprietor. If you do not feel the need for greater liability protection, continue filing Form 1040 and Schedule C when tax season arrives.

Do you want to work with a spouse or family member?

Perhaps you and your spouse, sibling, or parent have always wanted to launch a business together. If you thoroughly trust one another and are willing to take on additional liability, a general partnership may be your best option. Remember, both parties in a general partnership are liable for the company's financial obligations. A strong bond of trust is therefore crucial to success with this type of entity, as are protective legal forms such as partnership agreements.

Are you hoping for a quick and easy start to your journey as an entrepreneur?

It is no secret that starting a business is challenging, but as a sole proprietor it could be simpler than you expect. Sole proprietorships lack the formal federal and state filing requirements associated with other businesses. At most, you will file a fictitious business name statement. It is likewise easy to launch a general partnership; just complete a general partnership agreement to avoid or mitigate future conflicts.

Can you handle additional bookkeeping requirements?

As a sole proprietor or partner, you can get away with little to no recordkeeping. That changes quickly when you enter LLC or corporation territory. At a minimum, you will need to draft articles of organization or articles of incorporation. Additionally, you must maintain entirely separate records for your personal and professional endeavors.

Is liability a given in your industry?

Certain industries are uniquely prone to liability issues. As an LLC or corporation, you can shield your personal assets in the event of a lawsuit or other legal action. If you suspect that you will eventually face liability issues, it is worth the peace of mind to secure LLC protection.

Are you currently courting investors?

Procuring outside funding could prove next to impossible if you lack formal tax structure. As a corporation, you can sell stocks or shares to obtain much-needed funding, especially in the early stages. This may be a preferable option if you lack capital.

Are you eager to avoid double taxation?

Double taxation may be associated with corporate structures, but it can easily be avoided by setting up an S corp. LLCs also sidestep double taxation.

Do you intend to expand your business rapidly?

Sole proprietorships and general partnerships are best suited to those who intend to expand their businesses slowly and steadily. S corps and C corps are far more scalable. If you hope to grow your business quickly, it is worth your while to invest the extra time and funding upfront to ensure access to funding down the road. Do you hope to exceed 100 shareholders? If so, you will need to form a C corp as S corps heavily restrict shareholder numbers.

What are your long-term goals?

What happens when you retire? As a sole proprietor, your business ends as soon as you step aside. Conversion from partnership to sole proprietorship may be possible, but C corps provide the best opportunity for cementing your entrepreneurial legacy.

LegalNature Can Help You with Your Business Forms

The business decisions you make now could hold huge consequences in months and years to come. Weigh the concerns outlined above carefully to determine which type of business entity best suits your purposes.